TREASURY INSPECTOR GENERAL FOR TAX
ADMINISTRATION

Repeated Efforts to Modernize Paper Tax Return
Processing Have Been Unsuccessful; However, Actions Can Be Taken to Increase Electronic
Filing and Reduce Processing Costs

September 10, 2009

Reference Number:2009-40-130

This
report has cleared the Treasury Inspector General for Tax Administration
disclosure review process and information determined to be restricted from
public release has been redacted from this document.

This report presents the results of our review to assess the
Internal Revenue Service’s (IRS) strategy to convert paper-filed individual
income tax returns into an electronic format.This audit was included as part of our Fiscal Year 2009 Annual Audit
Plan under the major management challenge of Modernization of the IRS.

Impact on the Taxpayer

In Calendar Year 2008, the IRS received 156.3 million
individual income tax returns, of which 66.4 million (42.5 percent) were paper-filed.The IRS has devoted significant resources to
identify ways it could modernize its method for processing paper tax returns
but has had no success.Actions can be
taken including mandating electronic filing (e-filing) for paid preparers and developing processes to convert
paper returns into an electronic format which would significantly reduce paper
filings, processing costs, and error
rates, with the added benefit of faster tax refunds and more accurate tax
returns for taxpayers.

Synopsis

The IRS continues to receive large numbers of paper-filed
individual income tax returns despite a continued growth in e-filing.Processing of paper-filed tax returns costs
the IRS approximately $190.6 million.Error rates are considerably higher for paper-filed tax returns.Many errors are due to IRS employee keypunch
errors when inputting information from the paper tax returns into IRS
computers.In contrast, e-filed tax returns are sent through a
number of validations before the IRS accepts them.Unlike a paper tax return, an e-filed tax return is not accepted until
the validity check confirms the tax return is free of errors.Once notified of an error, the taxpayer or
preparer has to correct the tax return and resubmit it through e-filing or by paper.In some instances, rejected returns are not
resubmitted.

Because the
IRS has not been able to implement a modernized submission processing system to
convert paper tax returns into an electronic format, it has to continue to use
a labor intensive, costly, and error-prone system.

Repeated efforts have been initiated to modernize paper tax return processing
with no success.Significant resources
have been expended on developing modernization concepts.Since at least as far back as 1988, the IRS
has attempted to develop a system to replace its current paper tax return
processing.However, these efforts have resulted
in little more than conceptual visions.

While the IRS has not been able to move beyond the
conceptual stage for modernizing paper processing, there are actions that would
reduce paper filings and/or convert paper tax returns into an electronic
format.These options could result in a
significant increase in e-filing as
well as significant processing cost savings to the IRS.The options are:

Mandate
e-filing for paid preparers (this
option would require a change in the law).The majority of paid preparers are already familiar with operating
in an electronic environment.Most paid
preparers who filed paper tax returns[1]
actually used an electronic tax software preparation package and 70
percent also e-filed at least 1 tax
return, which indicates a familiarity with the electronic preparation and e-filing process.

Convert
residual paper returns into an electronic format.Updating the Modernized Submission Processing concept to include pursuing successful
processes followed by States that use scanning technology could provide
the IRS with an option to convert paper-filed tax returns into an
electronic format, thereby reducing processing costs associated with paper-filed
tax returns.

Implementation of these 2 options could result in a 26.9
percent increase in e-filing, with
cost savings of $66.6 million annually ($333 million over 5 years), and provide
the ability to convert 13.2 million paper tax returns into an electronic
format.

Recommendations

We recommended that the Commissioner, Wage and
Investment Division, pursue implementing successful processes followed by
States that use scanning technology (Optical Character Recognition and
Two-Dimensional Bar Codes) to convert
paper-filed tax returns prepared by individuals using a tax preparation
software package into an electronic format.

Legislative Recommendation

Consider mandating e-filing
for all paid preparers.

Response

IRS
management agreed with the two recommendations.The Wage and Investment Division will pursue the implementation of
processes that use scanning technology (Optical Character Recognition and
Two-Dimensional Bar Codes).Two-Dimensional Bar Codes will be a project proposal for the 2012
Modernization Vision and Strategy planning cycle.In the meantime, a new proposal will be
submitted to enhance legacy systems with Two-Dimensional Bar Code capabilities.The legislative recommendation is currently
under consideration by the Department of the Treasury and included in the
President’s Fiscal Year 2010 budget request.Management’s complete response to the draft report is included as Appendix
V.

Copies of this report are also being sent to
the IRS managers affected by the report recommendations.Please contact me at (202) 622-6510 if
you have questions or Michael E. McKenney, Assistant Inspector General for
Audit (Returns Processing and Account Services), at (202) 622-5916.

Paper-filed
individual tax returns accounted for 42.5 percent of tax returns received in Calendar
Year 2008.Processing of these returns
cost the IRS approximately $190.6 million.

The Internal Revenue Service (IRS) continues to receive
large numbers of paper-filed individual income tax returns despite a continued growth
in electronic filing (e-file).In Calendar Year 2008, the IRS received 156.3
million individual income tax returns of which 66.4 million (42.5 percent)
were paper-filed.As of May 1, 2009, the
IRS had received 40.6 million paper-filed tax returns, representing 30.9 percent
of the 131.6 million individual income tax returns received.The IRS recognizes that even though it is
getting closer to meeting its 80 percent e-file
goal,[2]
paper‑filed tax returns will continue to present a challenge in the
foreseeable future.Figure 1 provides
IRS projections on the volume of individual paper-filed tax returns for Calendar
Years 2010 through 2015.

·Error rates:[5]historically, less than 2.5
percent for e-filed tax returns
versus more than 25 percent for paper-filed returns.[6]

Error rates are considerably higher for paper-filed tax returns largely
because of IRS employee keypunch errors when inputting information from the
paper tax returns into IRS computers.In
contrast, e-filed tax returns
are sent through a number of validations which check for more than 600 possible
errors before the IRS accepts the tax return.E-filed tax returns that do not
pass the validation checks are rejected and sent back to the taxpayer or preparer
for correction.For example, validity
checks are performed on the taxpayer name, address, Social Security Number, and
year of birth. Errors include incorrect
Social Security Numbers of dependents, incorrect birthdates, numbers in an alphabetic
field, and invalid zip codes.Unlike a
paper tax return, an e-filed return
is not accepted as filed until the validity checks confirm the tax return is
free of these types of errors.Once
notified of an error, the customer has to correct the tax return and resubmit
it through e-file or by paper tax return.In some instances, rejected returns are not resubmitted.

Taxpayers
benefit when e-filing

Taxpayer e-file benefits include:

Faster refunds. With e-file,
taxpayers receive refunds in one-half the time it takes to file a paper
tax return and receive a refund check. Taxpayers who choose Direct Deposit can
receive their refund in as few as 10 days.

More accurate returns. In addition to the error checks built
into return preparation software, additional checks are performed during acceptance
processing of e-file returns. These additional checks reduce the chance
of receiving an error letter from the IRS.

Electronic confirmations.Taxpayers are notified electronically that
their returns have been received.

File now, pay later payment options. Taxpayers can file early and pay later by
scheduling an electronic funds withdrawal to be debited on or before April
15th. Taxpayers can also
pay by credit or
debit card when they e-file
their returns.[7]

Convenient Federal/State e-filing.Taxpayers in 37 states and the District of Columbia
can e-file their Federal and State
tax returns in 1 transmission to the IRS. The IRS forwards the State data to the
appropriate State tax agency.

Taxpayers can also receive no-cost e-filing by using the IRS’ Free File program. The Free File program is a free Federal online
tax preparation and e-filing program
for eligible taxpayers developed through a partnership between the IRS and the
Free File Alliance, LLC, a group of private-sector tax preparation companies. The program enables eligible taxpayers to use
commercial tax software for free. Taxpayers
with adjusted gross incomes up to $56,000 can use the standard Free File
options in Calendar Year 2009—that is approximately 98 million United States
taxpayers.

In addition, there is an option that opens up
the Free File program to nearly everyone, even those with incomes exceeding
$56,000.This option is Free File
Fillable Forms.These Fillable Forms
allow taxpayers to fill out their tax forms and e-file them with the IRS
at no cost. These forms are only
available through the Free File program link on IRS.gov (the public IRS
Internet web site). This option does not
include the step-by-step question and probe process, but it does allow
taxpayers to enter their tax data, perform basic math calculations, sign their
tax returns electronically, print their returns for recordkeeping, and e-file
their returns. This option may be
right for those who are familiar with the tax law, know what forms they want to
use, and do not need assistance.

The
IRS initiated an Advancing E-File Study in an effort to meet the e-file goal
set by Congress

The goal of the IRS’ Advancing E-file Study is to help the IRS validate and launch future studies,
research, and other activities to meet the goal of an 80 percent e-file rate set by Congress.Specifically, the IRS initiated a major
effort to collect, synthesize, and analyze all substantial data on the IRS e-file program in one document called
the Advancing E-file Study Phase 1 Report,
dated August 14, 2008. The report includes
the program’s history, stakeholders, taxpayer and preparer behaviors, related
programs and efforts, and options for expansion.The Phase 1 report does not include
recommendations on selecting or implementing specific options for advancing e-file, but lays the foundation for
doing so in future phases.

Phase 2 of the Advancing E-file
Study is underway and was planned for completion in spring/summer 2009; however,
it has been pushed back until the fall of 2009. Phase 2 will include a cost/benefit analysis
of the options to increase e-file based
on original research of taxpayer and preparer motivators and analysis of the
business and engineering/costing studies of those options.

This review was performed at the Wage and Investment
Division Submission Processing function offices in Lanham,
Maryland, and the Austin Submission Processing
Site in Austin, Texas, during the period December 2008
through May 2009.We conducted this
performance audit in accordance with generally accepted government auditing
standards.Those standards require that
we plan and perform the audit to obtain sufficient, appropriate evidence to
provide a reasonable basis for our findings and conclusions based on our audit
objective.We believe that the evidence
obtained provides a reasonable basis for our findings and conclusions based on
our audit objective. Detailed information
on our audit objective, scope, and methodology is presented in Appendix I.Major contributors to the report are listed
in Appendix II.

The IRS
process to receive and input paper-filed tax returns is extremely labor
intensive, costly, and prone to errors.

The IRS has devoted significant resources to initiate
studies to identify ways the IRS could modernize its method for processing paper
tax returns.In order to process paper
tax returns, information on the tax return must be entered by hand into a
computer by an IRS employee.This manual
process of inputting information into a computer system converts the information
into an electronic format, which then can be processed electronically.The IRS has studied different ways to automate
this labor-intensive and costly process.

However, none of these studies have moved beyond the concept
stage, which leaves the IRS expending significant resources ($190.6 million
annually) to process paper-filed tax returns.Current processing methods require the IRS to employ more than 5,000 data
transcribers during peak processing.For
decades, the IRS has used an elaborate manual system to process its U. S.
Individual Income Tax Return (Form 1040) series of paper tax returns.Paper returns are:

Received
and opened in a mailroom, then sorted and batched by return type.

Coded
and edited to prepare the returns
for transcription by ensuring all tax forms are attached, completed, and signed.Special codes are also applied as needed
to perform specific computations of tax liabilities, and then a Document
Locator Number is added.

Transcribed
into IRS computers.

Corrected
for taxpayer and IRS errors.

Filed for
storage.

Without a modernized paper submission processing system that
converts paper tax returns into an electronic format, the IRS will continue to
have to use its labor-intensive, error-prone, and costly system to process
paper-filed tax returns.In addition,
the manual transcription of information from paper-filed tax returns into IRS
computers has historically high error rates, which causes costly rework in
order to ensure returns are correctly processed and cause no harm to taxpayers.

Since at least as far back as 1988,
the IRS has attempted to develop a system to replace its current paper tax
return processing.However, none of
these efforts have resulted in more than conceptual visions.Figure 2 provides the progression of efforts
conducted to modernize paper submission processing.

Figure 2: Efforts
Initiated to Modernize Paper Submission Processing

1988

Document
Processing System – Developed to replace the IRS’ labor-intensive, paper-based
tax return processing system using imaging technology and Optical Character
Recognition.

Cancelled due to cost overruns.

2003

Submission
Processing Visioning Taskforce – Established to develop a 2–6 year
overarching vision for the future submission processing organization,
processes, and systems.

Concept was approved to pursue funding and then the concept
was rolled into the next proposal.

2004

Modernized Paper Pipeline Processing Proposal – Proposal for a
system capable of processing all IRS form types using the latest Optical
Character Recognition, Intelligent Character Recognition, and Two-Dimensional
Bar Code (2-D Barcode) recognition technology to capture information from the
different submissions and convert that information into an electronic format.

Source:
Treasury Inspector General for Tax Administration
research and interviews with IRS officials.

Modernized
Submission Processing is the IRS’ latest concept

The IRS has completed work on the Modernized Submission
Processing concept, its latest effort for modernizing paper tax return
processing.This concept provides for a
system that will automate the extraction of paper tax return information.The IRS projects that the system would cost an estimated $66.2 million in
development costs.After the system is fully implemented, the
recurring operation and maintenance costs are estimated to be $10.7 million per
year. The IRS had planned to request funding for the concept in Fiscal Year (FY)
2010; however, no funding was ultimately requested.

The concept provides for a paper processing system that will
use optical scanning, automated data extraction through Optical Character Recognition
and 2-D Barcodes, modernized and legacy data export, and return-of-record image
archive for the Form 1040 series of returns. The initial deployment was
proposed for August 2011 at one of the three campuses that process paper-filed
individual income tax returns with deployment to the remaining campuses in
August 2012.[8]The IRS anticipated that numerous benefits would
be realized once fully implemented and estimated that $67 million per year
would be saved.

$30
million from eliminating the Full-Time Equivalents[9]
required to process paper returns.This estimate is based on the labor and overhead costs for the
function used to input a paper tax return.

$16
million from eliminating the expense of maintaining the Service Center
Recognition Image Processing System.The cost savings for this system is the annual maintenance
costs.The Service Center
Recognition Image Processing System will be retired once the new system is
fully implemented.

$21
million from eliminating the expenses for the filing and storage of paper
tax returns.Files and storage
savings were based on savings from the contract with the National Archives
and Records Administration and the cost of IRS files operations.

The Modernized
Submission Processing Solution Concept[10] has been completed and was previously ranked
by IRS senior executives as one of the top new modernization priorities for the
FY 2010 investment portfolio.However,
no funding was ultimately requested for FY 2010, and it is no longer on the
IRS’ Enterprise Prioritization list for funding in FY 2010 or FY 2011.

While the IRS has not been able to move
beyond the conceptual stage for modernizing paper submission processing, there
are actions that would reduce paper filings and/or convert paper tax returns
into an electronic format.These options
can result in a significant increase in e-filing
as well as significant processing cost savings to the IRS.The options are:

Mandate
e-filing for paid preparers[11]
(this would require a change in current law).

Convert
residual paper returns into an electronic format.

Implementation of these options could result in a 26.9
percent increase in e-filing with processing
cost savings of $66.6 million annually as well as the ability to convert 13.2 million
tax returns[12]
into an electronic format.

Mandating e-file for paid preparers

A Federal mandate for paid preparers to e-file individual income tax returns would result in an increase of
26.9 percent[13]
in e-filed tax returns and reduce IRS
paper tax return processing costs by $66.6 million annually.[14]The majority of paid preparers are already
familiar with operating in an electronic environment.Most paid preparers who filed paper tax
returns actually used an electronic tax software preparation package and 70
percent also e-filed at least 1 tax
return, which indicates a familiarity with the electronic preparation and e-filing process. However, while paid preparers are willing to e-file returns, some taxpayers are reluctant to do so,
according to IRS management.Analysis of IRS return processing data for Processing
Year 2008 showed that:

26.4
million (40.8 percent) of the 64.8 million paper-filed Forms 1040 were
filed by 538,782 paid preparers; 21.6 million (81.5 percent)[15]
of these were prepared using an electronic tax software preparation
package and then mailed to the IRS.

378,056 (70 percent) of the 538,782
paid preparers also e-filed at least 1 tax return and,
of the remaining preparers who did not e-file
at least 1 tax return, 141,967 prepared a tax return using computer
preparation software, which indicates they are familiar with the
electronic preparation and e-filing
process.

Figure 3 illustrates the methods used by paid preparers
for paper return submissions.

Source: Treasury Inspector
General for Tax Administration analysis of the IRS’ Individual Return Transaction File[16] for
Processing Year 2008.

Federal law currently
prohibits the IRS from mandating e-filing

Federal law currently prohibits the IRS from requiring e-filing of individual income tax
returns.In order for a Federal mandate
of individual e-filing to be
implemented, the law would have to be changed.Advisory Groups and the Government Accountability Office have reported
to Congress the benefits that could be achieved by mandating e-filing:

·The Electronic Tax Administration Advisory
Committee (ETAAC) has advocated a Federal e-file
mandate for several years.In its June
19, 2008, Annual Report to Congress,[17]
the ETAAC reported, “At this time, [the] ETAAC believes that all reasonable
voluntary means have been exhausted with respect to encouraging preparers to e-file Individual Tax Returns, and it is
time to take a stance by announcing an e-file
mandate for tax return preparers.”

·The IRS Oversight Board agreed with the ETAAC’s
recommendation in its Electronic Filing 2008
Annual Report to Congress.[18]The Board supports the concept that Congress
should lift the statutory prohibition on e-filing
mandates for individual returns and give the IRS the discretion to implement
such e-file mandates in the future as
might be appropriate.

·The Government Accountability Office has also
suggested an e-file mandate.Its 2006 Filing Season report[19]
suggested that Congress should mandate e-filing
by paid tax preparers meeting criteria such as filing a certain number of
tax returns. The Government
Accountability Office stated, “With the slowing growth rate in electronic
filing, [the] IRS is missing an opportunity to generate additional savings. Federal and [S]tate mandates for electronic
filing have demonstrated success in increasing electronic filing; however, [the]
IRS currently lacks the authority to mandate electronic filing for certain
income tax returns such as individual returns filed by paid tax preparers. Using IRS estimates, savings from such a
mandate could be on the order of $60 million per year.”

It should also be noted that the President’s FY 2010 budget
request for the IRS contains a legislative proposal to expand e-filing requirements for paid
preparers. This proposal would allow
regulations to require that tax return preparers who file more than 100 returns
(or any other person who files more than 250 returns) e-file tax returns for individuals, estates, and trusts.

Many States are
already mandating e-filing for paid preparers

In
recent years, a number of States have adopted requirements mandating that
certain paid preparers must e-file all
tax returns they prepare.As of November
2008, 20 (47 percent) of the 43 States that have a personal State income tax[20]
have adopted some type of mandate that paid preparers e-file State individual income tax returns.Some of these States have included volumes of
tax returns prepared when determining which specific preparers have to e-file.For example, in 2004, the State of California
mandated that tax preparers who prepared more than 100 California individual income tax returns
during the previous year had to e-file
all of their clients’ current year returns.Also, in 2008, the State of Kansas
passed legislation that required paid preparers who prepare 50 or more returns
per year to e-file not less than 90
percent of returns eligible for e-filing.Figure 4 shows the States that currently have
an e-file mandate for paid preparers.

Figure 4: Map of
States With E-file Mandates for Paid Preparers

The map was removed due to its size.To see the map, please go to the Adobe PDF version of the report on the
TIGTA Public Web Page.

Significant processing
cost savings could be achieved as a result of a paid preparer mandate

A Federal mandate
requiring paid preparers to e-file would
provide significant processing cost savings to the IRS and would accelerate the
time it will take for the IRS to meet its 80 percent e-filing goal. In addition,
this would significantly reduce the volume of tax returns with keypunch errors
that would require correction.Figure 5
shows the expected e-filing increase
of an e-file mandate.

Figure 5: Projected
E-Filing Increase From an E-file Mandate

Projected Return Filings

Current Projection 2010

Percentage

With Mandate 2010

Percentage

Total Individual
Returns Forms 1040/A/EZ

140,903,300

140,903,300

Total Paper
Individual Returns

42,592,900

30%

16,145,138

11%

Total Electronic
Individual Returns

98,310,400

70%

124,758,162

89%

Source: IRS’ 2008 Calendar Year Return Projections for
the United States
and IRS Campuses
(Document 6186) and Treasury Inspector General for Tax Administration analysis
of the IRS’ Individual Return Transaction File for Processing Year 2008.

Mandating e-filing for paid preparers[21]
forindividual income tax returns
would result in a 26.9 percent increase[22]
in the number of e-filed tax returns
and would reduce IRS paper tax return processing costs by $66.6 million annually.Over 5 years, potential processing cost
savings could total approximately $333 million.

Management’s Response:The IRS agreed with this recommendation, which is currently
under consideration by the Department of the Treasury and included in the
President’s FY 2010 budget request.The
initiative will require e-filing by
tax preparers who file more than 100 tax returns in a calendar year.The proposal would be effective for tax
returns required to be filed after December 31, 2010.Since the Department of the Treasury and the
Administration have already considered the subject, the IRS does not plan to
take further action with regard to this recommendation.

Converting residual paper returns into an electronic
format

Electronic tax
preparation software companies currently provide tax software packages that enable
State tax agencies to optically convert paper-filed tax returns into an
electronic format using Optical Character Recognition and 2-D Barcodes. While mandating e-filing for paid preparers will significantly reduce the number of
paper returns received by the IRS, it will not eliminate them.In Calendar Year 2008, taxpayers submitted
36.5 million paper returns of which 13.2 million, or 36.2 percent, were
prepared using an electronic tax preparation software package.Yet these returns were mailed to the IRS as a
paper tax return.The IRS will still need
to develop a process to convert these residual paper returns into an electronic
format.

Updating the
Modernized Submission Processing concept to include pursuing successful
processes followed by States that use scanning technology, including the use of
Optical Character Recognition and 2-D Barcodes, could provide the IRS with an
option to convert paper-filed tax returns into an electronic format, thereby
reducing processing costs associated with paper-filed tax returns.

Representatives from
the State of California
told us that they partnered with tax software developers to provide a Scannable
section called a “Scanband” on State personal income tax returns.Currently, 24 states are using scanning technology including
scanbands and bar codes to improve the efficiency of tax return processing and
in most of the States the bar code technology captures all data on a State
individual income tax return.Figure 6
shows the States that currently use scanning
technology.

Figure 6: Map of
States Using Scanband and/or 2-D Barcodes

The
map was removed due to its size.To see
the map, please go to the Adobe PDF version of the report on the TIGTA Public
Web Page.

The
State of California Franchise Tax
Board uses Optical Character Recognition to capture
data and convert paper State personal income tax returns into an electronic
format.The Franchise Tax Board uses
high-speed scanners to take images of personal income tax returns and either
captures data from scannable forms or uses the return image to hand input the
data.The Franchise Tax Board’s imaging system
cost approximately $12.8 million for nonrecurring development costs and a total
of $2.5 million in annual maintenance and operating costs.Last year, the Franchise Tax Board processed
approximately 7 million paper personal income tax returns, of which 3.9 million
(55.7 percent) used data captured from scannable forms.CaliforniaState tax return preparers
use tax preparation software that creates a scannable section on the face of
the return called a “Scanband.”The
Scanband includes all the tax return information that is needed to process the
return, such as name, address, income, and refund amount.The remaining pages of the return contain the
same data that were included in the Scanband.Figure 7 shows the scannable version of a California Resident Income Tax
Return.

Figure
7 was removed due to its size.To see
Figure 7, please go to the Adobe PDF version of the report on the TIGTA Public
Web Page.

In another example,
the New York State Department of Taxation and Finance captures tax return data using
2-D Barcodes.This is a preferred option
based on conversations we had with one large e-file provider because it is less confusing to the taxpayer since
it looks like a regular tax return with a single cover sheet. A 2-D Barcode is a machine readable
representation of information encoded in a pattern of two dimensions.Returns that are prepared on a computer and
filed on paper have the data captured and printed in a 2-D Barcode capable of
being read by either hand-held or high-speed scanners.As of June 2009, the State of New York processed 39 percent
of its paper Tax Year 2008 returns using 2-D Barcodes.Figure 8 shows the cover sheet with 2-D Barcodes
for the New York Resident Income Tax Return.

Figure 8: New YorkState Cover Sheet for Form IT-201
Resident Income Tax Return

Figure
8 was removed due to its size.To see
Figure 8, please go to the Adobe PDF version of the report on the TIGTA Public
Web Page.

These scanning
technologies could be used in a rescaled version of the Modernized Submission
Processing concept to provide the IRS with options to further reduce processing
costs associated with residual paper-filed tax returns subsequent to an e-file mandate.In addition, to further reduce implementation
and equipment costs, the IRS should consider directing these taxpayers to
submit returns to a single return processing site. Implementing a process to convert paper-filed
tax returns that were prepared using a tax software package into an electronic
format could result in further reductions in paper-filed tax return processing
costs.

Recommendation

The Commissioner,
Wage and Investment Division, should:

Recommendation
2:Pursue the implementation of successful
processes followed by States that use scanning technology (Optical Character
Recognition and 2-D Barcodes) to convert
paper-filed tax returns prepared by individuals using a tax preparation
software package into an electronic format.

Management’s Response:The IRS agreed with this recommendation.The Wage and Investment Division will pursue
the implementation of processes that use scanning technology (Optical Character
Recognition and 2-D Barcodes).2-D
Barcodes will be a project proposal for the 2012 Modernization Vision and Strategy
planning cycle.In the meantime, a new
proposal will be submitted to enhance legacy systems with 2-D Barcode capabilities.Detailed requirements and timetables for that
proposal are being developed, with a targeted implementation date of January
2011.It should be noted that there are
budget and information systems prioritization constraints that may impact the IRS’
ability to implement this recommendation.

The overall objective of our review was to assess the IRS’
strategy to convert paper-filed individual income tax returns into an
electronic format.To accomplish our
objective, we:

I.Identified the process used to develop the strategy to
convert paper-filed individual income tax returns into an electronic format.

II.Identified the options the IRS considered and determined
adequacy of testing of the various options, the accuracy of cost information
included, and the method used to determine the potential benefits to be
realized.

III.Identified potential obstacles that could impact on the
timely implementation of the strategy as well as IRS efforts to address the
potential obstacles.

IV.Identified processes used by State tax agencies to
process paper-filed tax returns that could be used as a Best Practice.

V.Determined the effect of an e-file mandate for paid preparers by analyzing 90,472,107
individual income tax return records[23]
for Processing Year 2008 on the Individual Return Transaction File[24]
and identified 26,447,762 paper individual income tax returns prepared by paid
preparers.

This appendix presents detailed information on the
measurable impact that our recommended corrective action will have on tax
administration.This benefit will be
incorporated into our Semiannual Report to Congress.

Type and Value of Outcome Measure:

·Inefficient Use of Resources – Potential; return processing costs
of $66.6 million on 26,447,762 individual tax returns; $333 million in return
processing costs over 5 years (see page 7). It should be noted that realization of this
outcome measure is contingent upon enactment of legislation.

Methodology Used to Measure the Reported Benefit:

We used computer analysis to identify from the IRS Individual
Return Transaction File[25]
a universe of 26,447,762 paper individual income tax returns filed by paid preparers
in Processing Year 2008. Paid preparer
returns were identified as those that included a preparer Social Security
Number, Preparer Tax Identification Number, or Employer Identification
Number.It excluded returns prepared by
volunteer preparers, and we further limited paid preparers to those that
prepared six or more returns. IRS return
processing costs $0.35 for an e-filed
tax return versus $2.87 for a paper-filed tax return.If the tax law is changed to mandate e-file for paid preparers, processing
cost savings of $333 million over 5 years could be put to better use.

The response was
removed due to its size.To see the
response, please go to the Adobe PDF version of the report on the TIGTA Public
Web Page.

[1] For the
purpose of this report, we defined paid preparers as those that included a
preparer Social Security Number, Preparer Tax Identification Number, or Employer
Identification Number and prepared six or more tax returns.It excluded returns prepared by volunteer
preparers.

[2]The IRS Restructuring and Reform Act of 1998
required that paperless filing should be the preferred and most convenient
means of filing Federal tax and information returns.It should be the goal of the IRS to have at least
80 percent of all returns filed electronically.

[3] The data
processing arm of the IRS.The campuses
process paper and electronic submissions, correct errors, and forward data to
the Computing Centers for analysis and posting to taxpayer accounts.

[7] For
credit and debit card transactions, there is a fee charged by the service
providers. Fees are based on the amount
of the payment and may vary by service provider.

[8]
Processing of certain business returns was proposed for July 2013.

[9] A
measure of labor hours in which 1 Full-Time Equivalent is equal to 8 hours
multiplied by the number of compensable days in a particular fiscal year.For FY 2008, 1 Full-Time Equivalent is equal
to 2,096 staff hours.For FY 2009, 1
Full-Time Equivalent is equal to 2,088 staff hours.

[10] A Solution
Concept is the first step toward the development of a modernization investment proposal
and documents the project scope, assumptions, timeline, risks, and the technical
solution envisioned.

[11] For the
purpose of this report, we defined a paid preparer as those who included a
preparer Social Security Number, Preparer Tax Identification Number, or
Employer Identification Number and prepared six or more tax returns.We excluded returns prepared by volunteer
preparers.

[12]
Prepared by taxpayers using tax preparation software then printed and mailed.

[20]Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming do not have a
personal State income tax.

[21]The IRS requires paid preparers to sign the tax returns
they prepare and to identify themselves using eithertheir Social Security Numbers or Preparer Tax Identification
Numbers.If the preparer is
self-employed or a member of a firm, they are also to provide their Employer
Identification Numbers.Our analysis
identified returns that included a preparer Social Security Number, Preparer
Tax Identification Number, or Employer Identification Number and excluded
returns prepared by volunteer preparers.The analysis further limited paid preparers to those that prepared six
or more returns.This criterion was
based on preparer identification issues reported in our report entitled Inadequate Data on Paid Preparers Impedes
Effective Oversight (Reference Number 2009-40-098, dated July 14, 2009).

[23] To
assess the reliability of computer-processed data, programmers in the Treasury Inspector General for Tax Administration
Office of Information Technology validated the extracted data, and we verified
the appropriate documentation. In
addition, run-to run balancing was performed and the data in the selected fields
were analyzed to verify the validity of the data.

[24] The
Return Transaction File contains all edited, transcribed, and error-corrected
data from the U.S. Individual Income Tax Returns (Form 1040 series) and related
forms for the current processing year and 2 prior years.

[25] The
Return Transaction File contains all edited, transcribed, and error-corrected
data from the U.S. Individual Income Tax Returns (Form 1040 series) and related
forms for the current processing year and 2 prior years.